The euro (EUR) is trading under slight pressure against the British pound (GBP) on Tuesday as investors reassess the monetary policy outlook of major central banks amid inflation concerns related to higher oil prices stemming from the US-Iran conflict. At the time of writing, the EUR/GBP rate was trading near 0.8710, away from the daily high of around 0.8739.
Markets are increasingly pricing in the risk of prolonged supply disruptions through the Strait of Hormuz, a key shipping lane that accounts for almost 20% of global oil flows. Concerns intensified after an adviser to Iran’s Islamic Revolutionary Guard Corps said on Monday that Iran would “set fire to any ship attempting to pass through the Strait.”
In response, investors reduced expectations for a Bank of England (BoE) rate cut at its March meeting, with market valuations less than 50% likely, Bloomberg reported on Monday.
The sell-off provides moderate support for the pound. The pound, however, lacks forceful further buying as political uncertainty persists in the UK amid renewed scrutiny of Prime Minister Keir Starmer’s leadership.
Meanwhile, stronger than expected inflation data did not provide support for the euro. Preliminary data published by Eurostat showed that inflation in the euro area increased in February. The Core Harmonized Index of Consumer Prices (HICP), which excludes volatile food and energy prices, rose 0.8% m/m, rebounding after a 1.1% decline in January.
On an annual basis, core inflation accelerated to 2.4%, beating market expectations of 2.2%. Meanwhile, the headline HICP rose by 0.7% m/m after falling by 0.6% in the previous month, while the annual rate rose to 1.9%, above the forecast of 1.7%.
European Central Bank (ECB) officials have also highlighted the risks posed by the US-Iran conflict. ECB policymaker Yannis Stournaras said the central bank was closely monitoring developments, adding there was “no rush to change policy”, while warning that inflation could face upward pressure if the conflict persists.
ECB policymaker Francois Villeroy de Galhau also warned against speculation on the next move in monetary policy, stating that “it would be a mistake to predict changes in interest rates in a hurry.”
Frequently asked questions about central banks
Central banks have a key task of ensuring price stability in a country or region. Economies constantly struggle with inflation or deflation resulting from price fluctuations of certain goods and services. A constant enhance in the prices of the same goods means inflation, a constant fall in the prices of the same goods means deflation. The task of the central bank is to maintain demand at an appropriate level by changing basic interest rates. For the largest central banks, such as the US Federal Reserve (Fed), the European Central Bank (ECB) and the Bank of England (BoE), the task is to keep inflation close to 2%.
The central bank has one significant tool at its disposal to raise or lower inflation, and that is to change its benchmark interest rate, commonly known as the interest rate. At the times indicated above, the central bank will issue a statement containing its key interest rate and provide additional justification for why it is maintaining or changing (lowering or raising) it. Local banks will adjust their savings and loan rates accordingly, which will in turn make it harder or easier for people to earn money on savings and for companies to take out loans and invest in their businesses. When a central bank increases interest rates significantly, it is called monetary tightening. Lowering the reference rate is called easing monetary policy.
The central bank is often politically independent. Members of the central bank’s policy board go through a series of panels and hearings before being appointed to a position on the policy board. Each member of this board often has some belief about how the central bank should control inflation and the resulting monetary policy. Members who want a very loose monetary policy, with low interest rates and low-cost credit, to significantly stimulate the economy, while being content with inflation just above 2%, are called “doves”. Members who rather want higher interest rates to reward savings and who want to keep inflation contained all the time are called “hawks” and will not stop until inflation reaches 2% or just below.
Typically, each meeting is chaired by the chairman or president, who must reach a consensus between hawks and doves and has the final say when votes are split to avoid a 50-50 tie on whether current policy needs to be adjusted. The chairman gives speeches, which can often be followed live, during which the current state of monetary policy and prospects is conveyed. The central bank will try to push through its monetary policy without causing wild swings in interest rates, stocks or its currency. All central bank members will present their position to markets ahead of the policy meeting. In the days before a policy meeting, until a up-to-date policy is announced, members are prohibited from speaking publicly. This is called the blackout period.
